Lecture on Macroeconomics:

Balance of Payment and External Stability

Dr David Kim
Economics Department
The University of Sydney

FOCUS
ON
ECONOMICS

Why study economics?

Here are some reasons to study economics.
To be culturally literate and better understand the
world (you look more intelligent at a cocktail party!)
Economy affects our lives (e.g. harder to get a job in
recession, decisions on taking out a mortgage, saving
and investment are affected, etc...).
We can have better, if not best, answers to many
questions and elect a better government to keep the
bastards honest Cheryl Kernot.

What is a Nations Balance of Payments?

THE AUSTRALIAN BALANCE OF PAYMENTS, 2006-07 ($billions)

CURRENT ACCOUNT

Exports of goods (1)

169.6

Imports of goods (2)

-183.4

Net export of goods (1) - (2) = (3)

Net exports of services (4)

-13.8
1.8

Trade balance (3) + (4) = (5)

-12

Net income & transfers (6)

-46.3

-59.2

Current account balance (deficit=-) (5) + (6)

CAPITAL (& Financial) ACCOUNT

Net private portfolio investment inflows and transfers (7)

76.7

Net private direct investment inflows (8)

-0.04

Total net private investment inflows (7)+(8)=(9)

Net other investment (10)

Reserve assets (11)

Capital account balance (deficit=-) (9)+(10)+(11)

76.03
0.7
-20.1

59.3
3

The Current Account

Australias Current Account Balance (% of GDP) 1988 - 2008
3.0000

TBY
2.0000

NETINCTRY
CAY

1.0000

Sep-08

Sep-07

Sep-06

Sep-05

Sep-04

Sep-03

Sep-02

Sep-01

Sep-00

Sep-99

Sep-98

Sep-97

Sep-96

Sep-95

Sep-94

Sep-93

Sep-92

Sep-91

Sep-90

Sep-89

-1.0000

Sep-88

0.0000

-2.0000
-3.0000
-4.0000
-5.0000
-6.0000
-7.0000
-8.0000

The Capital and Current Accounts

Why is there a balance between the current and
capital accounts?
Tim
Buys an imported
German car from an
Australian dealer
$100,000A (paid into
car dealers bank a/c)
Current a/c debit of
$100,000A

Tong
Now has $100,000A
[1] Spend the $100,000A on a
Gold Coast holiday (Current
a/c credit of $100,000A)
[2] Leave the money in the
bank (Capital a/c credit of
$100,000A)
[3] Buy shares in Australian
companies (Capital a/c credit
of $100,000A)
5

Capital Flows
Capital inflows = purchase of domestic assets by
foreign residents
Any time an Australian resident
borrows from an overseas
resident, there is a capital inflow
(recorded as a credit in the capital
account)
Capital outflows = purchase of foreign assets by
domestic residents
Any time an Australian
resident lends to an overseas
resident, there is a capital
outflow (recorded as a debit
in the capital account)
6

The Capital and Current Accounts

Some Cautions

The BoP = CA + KA = 0 does not hold for

countries with capital controls (e.g. China)
The sum of all CA deficits across the
globe is still negative! Are we having a
deficit against Martians? Measurement
errors!
7

Saving and the Trade Deficit

Balance on the current a/c + balance on the
capital a/c = 0
Any current a/c deficit must be matched by a capital
a/c surplus

SI

capital a/c
surplus (deficit)

X-M
current a/c
deficit (surplus)

e.g. if NS > I, have a

capital a/c deficit and this
is associated with X > M, a
current account surplus

Saving and the Trade Deficit

Australia
r
S

Nothing evil
about a current
account deficit

rworld
I
S,I
Capital Inflow: Capital a/c surplus & current account deficit

Saving and the Trade Deficit

Japan
r
S
rworld

I
S,I
Capital outflow: Capital a/c deficit & current account surplus

10

Budget deficits and External deficits

S1
S0

rworld

I
S,I
The Twin Deficits Hypothesis

11

Saving and the Trade Deficit

What determines a nations current account?
S and I
Domestic interest rates versus international rates.
Choice between current vs. future consumption
International savings and investment
Should policymakers try to lower current account deficits?
Persistent CADs reflect a symptom of systemic imbalances in the economy.
BUT macro policy is ill-suited to correct for them. Why?
12

Saving and the Current Account

Australians do not save enough to fund investment.

Source: Bernanke and Blinder (2008)

13

The Capital and Current Accounts

The US current account deficits - persistent CA deficits can be a real problem!
0.0200
0.0100

Mar-05

Mar-02

Mar-99

Mar-96

Mar-93

Mar-90

Mar-87

Mar-84

Mar-81

Mar-78

Mar-75

Mar-72

Mar-69

Mar-66

Mar-63

-0.0100

Mar-60

0.0000

-0.0200
-0.0300
-0.0400
-0.0500
-0.0600
-0.0700
-0.0800

14

The 2007/8 Global Financial Crisis

S&P/Case-Shiller U.S. National Home

Price Index
200.00
180.00
160.00
140.00
120.00
100.00
80.00
60.00
40.00
20.00

Datasource: Case-Shiller

M a r-0 8

M a r-0 7

M a r-0 6

M a r-0 5

M a r-0 4

M a r-0 3

M a r-0 2

M a r-0 1

M a r-0 0

M a r-9 9

M a r-9 8

M a r-9 7

M a r-9 6

M a r-9 5

M a r-9 4

M a r-9 3

M a r-9 2

M a r-9 1

M a r-9 0

M a r-8 9

M a r-8 8

M a r-8 7

0.00

Source: Hubbard and Mayer (2009)

15

The 2007/8 Global Financial Crisis

Bank Run in the UK

Source: http://www.flickr.com/photos/89319548@N00/1378965141/

16

Summary
For countries with a flexible exchange rate system, current
account imbalances (as BoP =0) matter!
Current account reflects how firms, households and
governments save and borrow for consumption and investment.
Persistent external imbalances imply some underlying domestic
distortions, and global imbalances too!.
Macro policy is ill-suited for this. Target the causes not the
symptoms!
Rapid deterioration in the CAD signals a serious problem
waiting to happen! Example: Asian financial crisis, US
subprime crisis.
17